By Ding Lu

China’s Great Pump Priming

The term san-qi-die-jia (the three entangled
issues) has set the tone for macroeconomic policy making in the past few years
since the leadership succession at the Chinese Communist Party’s 18th National
Congress in 2012. The three entangled issues refer to dealing with the slowdown
in economic growth, making difficult structural adjustments, and absorbing the
effects of the previous economic stimulus policies in the aftermath of the 2008
global financial crisis (Yi, 2014).

In his recent
report to the 12thNational People’s Congress (NPC), Premier Li
Keqiang reiterated the term and the corresponding three-buzzword strategy to
tackle the issues: stabilizing (growth), adjusting (structures), and preventing
(systematic financial risks). He emphasized that, to adapt to the “new normal”
of moderate growth, the government will not rely on pump priming stimulus but will
instead focus on reforms-and-opening endeavors that “invigorate market vitality.”
In his narratives of the government’s policy making and achievements in the
past year and the 12thFive-year Plan period (2011-2015), all the
three issues appear to have been well tackled in a measured and balanced
manner. In particular, it is high on the government’s agenda to solve the
problems left by the previous round of pump priming, including overcapacity of
production and stockpiling of inventory in some industries, and overleveraging
in some businesses and localities. A series of economic indicators cited in the
report paint a picture of prudent management of the economy (Li, 2016).

A closer look at
the official statistics, however, suggests a more hawkish practice of macroeconomic
policies. Every year since 2008, China has run an overall government deficit
more than 1.0 percent of GDP. As shown in Figure 1, after the 2008 global financial
crisis, the fiscal deficit shot up over six times from the previous year to RMB
778 billion in 2009, equivalent to 2.25 percent of that year’s GDP. The deficit
was reduced in 2010 and 2011 but soon resumed its expansionary path. Either measured
in nominal or real value, the annual fiscal deficit exceeded the 2009 level for
three subsequent years from 2013 to 2015. Last year, the fiscal deficit rose by
43 percent from the previous year in real terms to reach a record level of RMB
1.62 trillion, or 2.3 percent of GDP.

On top of that, bond
quotas worth RMB 600 billion have been allocated to meet local governments’
need for new fiscal finance, and new bond quotas worth RMB 3.2 trillion were
granted in 2015 to help local governments finance their debt payment needs.
Administrative procedures have also been streamlined to help local governments
raise money for public-service projects by issuing local bonds or via
public-private partnerships (Central Government, 2015).

Figure 1. Fiscal Deficit

Source: Compiled from National Data, National Bureau of Statistics of
China.

Note: Figures for 2016 is
estimated from Li (2016).

Notwithstanding
the record scale of the fiscal stimulus in 2015, Premier Li announced in the
report to the NPC that “the active fiscal policy will be reinforced” in 2016.
The fiscal deficit is planned to rise to RMB 2.18 trillion, a further 35
percent increase from the 2015 level (Li, 2016). That will raise the deficit-to-GDP
ratio to an unprecedented level of 3.0 percent.

An expansionary
monetary policy has also been aggressively pursued. In just the period of a
year, between November 2014 and October 2015, the People’s Bank of China (PBOC)
cut leading basic interest rates six times from 3.00 percent to 1.50 percent.
From February 2015 to February 2016, it also lowered required reserve ratios of
banks and deposit institutions six times from 20.0 percent to 16.5 percent. It
is evident in Figure 2 that, compared to the cuts in the aftermath of the 2008 global
financial crisis, the current round of leading interest rate cuts since November
2014 has been of about the same magnitude and has led to an even lower rate
while the extent of the current round of deposit reserve ratio cuts has been even
more substantial.

Besides, in
contrast to the RMB’s firm peg to the US dollar after the 2008 financial crisis,
the Chinese currency has depreciated by more than 4 percent against the US
dollar in one stroke after its exchange rate mechanism was overhauled in August
2015.

Figure 2. Leading Interest Rates and Deposit Reserve Ratios

Source: Compiled from data.eastmoney.com.

The double-cut
moves by the PBOC have fueled the biggest round of monetary and credit
expansion since 2009 (Figure 3). Increased credit by financial institutions has
amounted to more than 15 percent of GDP every year since 2012 and jumped to
about 26 percent of GDP last year, compared to the peak of 28 percent reached
in 2009. The scale of total credit measured by its ratio to GDP was about 100 percent
15 years ago but has risen to 147 percent in 2015 and is expected to grow
further to above 150 percent this year. Money supply measured by M2-to-GDP
ratio also expanded quickly from around 150 percent in 2008 to over 200 percent
last year.

Figure 3. Money and Credit Expansion

Source: Compiled from National Data, National Bureau of Statistics of
China.

Note: Figures for 2016 is
estimated using statistics of the first two months of 2016.

Premier Li has
pledged that “the monetary policy of stability should be flexibly appropriate”
in 2016 and both M2 and social finance will grow 13 percent, one percentage
higher than the planned rate in 2015 (Li, 2016). What has happened in the first
two months of this year is that the rate of credit increase year-on-year has already
reached almost 14 percent. It is not surprising that the actual M2 growth rate
in 2015 was 13.3 percent when the target rate was set at 12 percent. Based on
this trend, the M2-to-GDP ratio is likely to exceed 210 percent this year.

Despite all the
policy rhetoric of the “three entangled issues” and the three-buzzword strategy
of stabilizing (growth)-adjusting (structures)-preventing (risks), it is now
clear that the temptation of using economic steroid shots to prop up growth has
been too strong for the policy makers in Beijing to resist. Rather than clearing
up or “absorbing” the wasted projects and piles of bad debt left from the previous
round of policy stimulus, the government is creating another round of
fiscal-monetary pump priming. Except for setting a new record of scale, how will
this round be different?

References

Central
Government. (2015, September 8). Summary of fiscal policies and measures to
support growth stabilisation. Retrieved from
www.gov.cn/xinwen/2015-09/08/content_2927226.htm.

Li, K. (2016,
March 5). Report on the Work of the Government. Delivered at the Fourth Session
of the 12th National People's Congress of the People’s Republic of China.